JM Smucker: Fair at $100

-Seven Year Average Revenue Growth Rate: 15.4% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 10.7%
-Seven Year Average Dividend Growth Rate: 9.5%
-Current Dividend Yield: 2.29%
-Balance Sheet Strength: Strong

For solid if not impressive risk-adjusted returns, J.M. Smucker seems well-positioned and fairly valued.


The J.M. Smucker Company (symbol: SJM) was founded in 1897, is headquartered in Ohio, and is still run by the Smuckers family.

The company produces jam, jelly, preserves, peanut butter, sandwich products, ice cream toppings, baking products, oil, juices, and coffee. The company draws its revenue mostly from North America, but has international ambitions as well. The company focuses primarily on having the #1 brand in any given category.

For coffee brands, Smuckers has gone on a buying spree. They acquired the large Folgers brand of coffee from Procter and Gamble, and they also sell Dunkin Donuts coffee for retail markets. They now sell Millstone, Cafe Bustelo, and Pilon coffee, with the last two being popular among Hispanic demographics, statistically speaking.

K-Cups are becoming more popular, and Smuckers has offerings in this area, including from their Folgers Gourmet Selections brand. Smuckers does face strong coffee competition from several brands, with Starbucks and Green Mountain Coffee Roasters being the two most worth mentioning.

Coffee contributes 39% of SJM sales.

U.S. Retail Consumer Foods
The company’s original flagship product is their line of Smuckers fruit spreads: jams, jellies, and preserves. They were smart to acquire the Jif peanut butter brand as well, and they also control or license other brands like Crisco, Pillsbury, and Hungry Jack.

This segment contributes 38% of SJM sales.

International, Foodservice, and “Natural” Foods
Some of the company’s largest brands compete internationally, and they also have brands dedicated to certain markets, like Canada. For “natural foods” in this category, they have Santa Cruz Organic and R.W. Krudsen Family. In fiscal year 2012, the company invested in Seamild, a leading provider of oats products throughout China.

This segment contributes the remaining 23% of sales.

Valuation Metrics

Price to Earnings: 19
Price to Free Cash Flow: 22
Price to Book: 2.1


Smuckers Revenue
(Chart Source:

The revenue growth rate is high at 15.4% per year averaged over the past 7 years. This is because the company issued new shares for capital to make acquisitions up until 2010.

Earnings and Dividends

Smuckers Dividends
(Chart Source:

Over the same 7 year period, EPS growth was 10.7% per year while dividend growth was close behind at 9.5% per year. The most recent dividend increase was 11.5%.

The current dividend payout ratio from earnings is about 40%, so the dividend is well-covered and has room to grow.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.3%
2013 2.3%
2012 2.5%
2011 2.6%
2010 2.3%
2009 2.9%
2008 2.4%
2007 2.3%
2006 2.3%

As can be seen by the chart, except for certain points of volatility, Smuckers stock has maintained a fairly consistent mediocre dividend yield. The price of the stock has risen at almost exactly the same rate as the dividend growth.

How Does SJM Spend Its Cash?

Over the past three years combined, Smuckers brought in about $1,300 million in reported free cash flow. About half of that, or $630 million, was spent on dividends. Over $1 billion was spent to buy back stock, and the outstanding share count has decreased by nearly 8% cumulatively over the past three years. Approximately $730 million was spent on acquisitions.

Balance Sheet

Smuckers has a total debt/equity ratio of under 45%, although goodwill makes up about 60% of existing shareholder equity due to acquisitions. The total debt/income ratio is about 4x. The interest coverage ratio is just over 10x, indicating that Smuckers can easily pay all debt interest.

Overall, the balance sheet is in a strong position. Management has used leverage appropriately and conservatively.

Investment Thesis

Smuckers has substantially outperformed the market over the last 15 years due to a series of large successful acquisitions and good management of their capital. A diverse set of top brands gives the company a steady, defensive position while outperforming, and therefore the risk-adjusted returns have been particularly good.

Looking to the future, management aims for sales growth of 6% per year (organic growth of 3-4% and acquisition growth of 2-3%), and EPS growth of 8% driven primarily from that sales growth plus share buybacks. With the dividend, this would lead to total returns of 10-10.5% or so, which is higher than the S&P 500 historical average.

The internal strategic efforts appear to be a page out of Pepsico’s current playbook with their “Healthy for You”, “Good for You” and “Fun for You” levels of products representing the spectrum of how bad for you a given product is. Smuckers has “Good for You”, “Easy for You” and “Makes You Smile”.

Overall focus of the company includes concentrating on North America and China rather than expanding everywhere, focusing on health products such as ones with natural ingredients or special-diet options such as gluten free products, and continuing to look for bolt-on acquisitions to complement their previous transformational acquisitions.


Like any company, SJM has risks. Being a food company, they are a defensive stock, but they always face risk in two main forms: commodity costs and cheaper private label competition. In addition, in contrast to many large American companies, Smuckers has most of its sales and operations in North America, meaning it is geographically concentrated.

Packaged food is a competitive business, and Smuckers expects flat volume growth and a 1% sales reduction in 2014, but decent EPS and dividend growth.

Conclusion and Valuation

With the DJIA and S&P 500 continuing to hit new records, stocks at a decent valuation are difficult to find, and this is especially so for relatively stable blue-chips that you can buy and set aside for a while. In addition to increasing risk and reducing overall returns, this pushes dividend yields lower across the market, which reduces the amount of dividend income you can buy with any given amount of cash.

That being said, SJM neither appears to be a clear value or a clear overvaluation. While the markets soared upward throughout 2013, SJM actually fell over ten bucks from its mid-year high.

The earnings multiple approach should work well for valuating the company. If management is successful and raises EPS by 8% per year over the next 10 years, then the EPS figure will be $10.57 at that time. Putting an earnings multiple of 16 on that EPS figure in ten years (compared to an earnings multiple of 19 now) puts the stock price at about $169. If dividends continue to be paid with a payout ratio of 40%, that’ll be about $30 in cumulative dividends over those ten years, or about $42 if they are reinvested into the stock. So, $169 + $42 = $211 in value in ten years.

That’s an annualized rate of return of about 7.5% from the current price of $101, which is neither particularly appealing, nor particularly bad for a defensive company in a highly valued market, and assumes a significant drop in valuation. If instead the valuation remains constant at a P/E of about 19, the rate of return under the same conditions would be about 9% per year, which is in line with historical S&P 500 growth.

Excluding any major company missteps, it seems unlikely that investors would be disappointed having invested in Smuckers stock at the current price over the long-term, and so I view the company as a reasonable, if not appealing, buy. There is of course a large risk of near or mid-term stock price declines during a market correction.

Full Disclosure: As of this writing, I am long SJM.
You can see my dividend portfolio here.

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Johnson and Johnson: Let it Dip to a 3% Yield

-Seven Year Average Revenue Growth Rate: 4.2% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 1.6%
-Seven Year Average Dividend Growth Rate: 9.4%
-Current Dividend Yield: 2.83%
-Balance Sheet Strength: Perfect

The company has a good foundation for growth after a difficult few years, but the current price in the low $90’s leaves little or no margin of safety.


Johnson and Johnson (NYSE: JNJ) was founded in 1886 and today is the largest and among the most diverse of health care companies in the world. The company consists of three segments: Medical Devices, Pharmaceuticals, and Consumer.

Medical Devices and Diagnostics Segment
This segment was responsible for $27.4 billion in sales in 2012, which is up 6.4% from the previous year. Orthopaedics is the largest unit, accounting for over a quarter of the sales from this segment. Surgical care is the next largest unit, accounting for nearly a quarter of segment sales. The remaining units are vision care, diabetes care, specialty surgery, cardiovascular care, diagnostics, and infection.

Pharmaceuticals Segment
Johnson and Johnson brought in $25.4 billion in sales for 2012 with pharmaceuticals, and this figure was up 4% from the previous year. Immunology is the largest pharmaceutical unit (nearly a third of segment sales), followed by neuroscience (about a quarter of segment sales), infectious diseases, oncology, and other.

Consumer Segment
Consumer sales were $14.4 billion in 2012, and this figure was down 2.9% from the previous year. OTC is the largest unit accounting for nearly a third of segment sales. Skin care is another big unit, accounting for a quarter of segment sales. Other units are baby care, oral care, women’s health, and wound care.

Valuation Metrics

Price to Earnings: 20.7
Price to Free Cash Flow: 21.2
Price to Book: 3.8


Johnson and Johnson Revenue
(Chart Source:

The revenue growth rate over the latest seven year period was about 4.2% per year on average. Over the trailing twelve month period, the company has sustained strong revenue growth, going from $67.2 billion in 2012 to about $70 billion over the last four quarters.

Earnings and Dividends

Johnson and Johnson Dividends
(Chart Source:

The EPS growth rate over this period was only 1.6%. But, EPS for the trailing twelve month period is much higher than it was in 2012, and using that adjusted time period, the EPS growth rate is 2.7%. Overall, JNJ has had weak earnings growth.

The dividend growth rate over this period has been a solid 9.4% per year, which when combined with a yield of 3% or so represents very solid long-term returns. The dividend payout ratio from earnings however, has increased over the last decade from comfortably under 40% to nearly 60%.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.9%
2013 3.5%
2012 3.5%
2011 3.5%
2010 3.0%
2009 3.0%
2008 2.5%
2007 2.2%
2006 2.1%
2005 1.8%

The yield for Johnson and Johnson is currently at a low point. Although JNJ boosted its dividend for 2013, the fact that the stock price roared from the low $70’s to the low $90’s during the year to date, has increased the valuation and decreased the current dividend yield.

How Does JNJ Spend Its Cash?

During the fiscal years of 2010, 2011, and 2012, the company brought in nearly $38 billion in free cash flow. Over the same period, the company paid about $18.5 billion in dividends, another $18.2 billion on share repurchases, and about $8.5 billion on net acquisitions.

Balance Sheet

Johnson and Johnson is one of only a very few non-financial companies that maintains a perfect AAA credit rating.

The total debt/equity ratio is about 21%, and less than a third of existing shareholder equity consists of goodwill. The existing amount of total debt is less than 1.2x the annual net income figure, and the interest coverage ratio is 35x, which is extremely well-covered.

The company generates positive free cash flow each year from a highly diverse sales base, and often it’s a higher figure than net income.

Investment Thesis

The company has started fresh with a relatively new CEO (of which there have only been 7 in over 120 years of operating history) with substantial industry experience, and with several difficult years behind the company, the next few years look brighter.

Johnson and Johnson is often viewed as the quintessential blue chip stock. The combination of a particularly strong balance sheet, five consecutive decades of annual dividend growth without a miss, strong free cash flow generation, and a highly diverse sales base, is hard to compare to any other company.

Most segments have various durable economic advantages which help to protect their cash flows. For example, the pharmaceutical segment, like other pharmaceutical companies, uses a series of patents to maintain a consistent pipeline and portfolio of patented drugs, and because of their size, they can fund the largest of R&D projects or they can acquire drugs for their pipeline. This makes their pipeline rather consistent from year to year. The medical devices segment is similar, with advanced patented devices created from one of the largest medical device segments in the world. The consumers segment is a bit different in that it relies on brand strength. Each of the three segments is supported by the others, so a weak pharmaceutical period can be balanced by strong medical device sales during that time, or as we saw in previous years, a weak consumer segment can be balanced by the pharmaceuticals and medical devices. Most of JNJ’s products are protected from recessions due to their rather necessary nature, with the exception of some of their over-the-counter products which are vulnerable to market share losses to private label products during those times.


Although the company is large and well-diversified, the complex nature of the company results in numerous risks. 2010 was a particularly difficult year for the company, as they recalled 43 over-the-counter medications due to systemic quality control issues in their subsidiary that is responsible for this lineup of products, recalled hip replacements due to a revision ratio that was far above acceptable levels, and faced a shareholder lawsuit regarding these quality issues and other aspects of company governance.

The pharmaceuticals segment, like any company in the industry, has pipeline risk. It can take billions of dollars to develop or acquire a blockbuster drug, and a weak pipeline of upcoming drugs can mean that sales will be lackluster in upcoming years. Unexpected events of drugs failing approval or showing to be ineffective can be a major blow to the segment. Currently the pipeline is strong, and unlike pure pharmaceutical companies, Johnson and Johnson buffers this risk with their other business segments.

Litigation is a constant risk for any large health care company, because so many lives are affected so dramatically. Products can mean the difference between life and death for patients, and something like a hip replacement that has a revision rate of over 10% compared to the typical and acceptable 1% can mean major financial losses, recalls, and/or litigation.

Conclusion and Valuation

There’s little doubt that overall, JNJ is a particularly strong company. Just about every metric is spectacular from the balance sheet to the cash flow generation to the diversification to the dividend safety. Still, the company does have downsides.

Growth has been poor in the recent several years due to the recalls which were acting as anchors on profitability, as well as the financial crisis and recession to a limited extent. On one hand, the fact that the company weathered a cluster of problems with flat sales base and earnings base shows the strength of the company. On the other hand, several years of poor growth does have a major negative impact on shareholder returns.

With a strong pipeline and with better quality oversight in place, the company is in a good state for growth going forward. The one problem, of course, is valuation. Johnson and Johnson outperformed the S&P 500 by nearly 10% year to date, and the S&P 500 itself outperformed its average growth rate during 2013 to reach record highs. Last year in the JNJ stock analysis report, I stated similar views about JNJ- that it was in a good position for growth (which based on revenue growth has been true), but at that time the stock was in the high $60’s and I was cautiously optimistic about it being a buying opportunity at that price.

Now at $93/share, we’re looking at a similar situation with a much higher valuation. Using the earnings multiple valuation approach, if the company grows EPS by 8% per year over the next 7 years on average, and we place an earnings multiple of 18x on the stock at the end of that seventh year, then the price will be around $138. The investor will have received about $26 in dividends per share, and if reinvested, can expect another $8 or so in value. The seventh year value therefore would be $184, which is roughly double the current value. This translates into a rate of return of about 9%, which is not bad on a conservative dividend payer.

But that doesn’t leave any margin of safety. If EPS growth averages only 7%, the rate of return under the same circumstances would be down to a bit over 8%, and if the earnings multiple at that time is 16 instead of 18, the annual rate of return is down to about 7%.

In conclusion, I believe that few investors would be disappointed several years from now with a purchase of JNJ stock today, but I don’t think it’s in a good position to outperform unless estimates use very optimistic growth estimates. So, the price is fair but not ideal, in my view. The yield is historically low for the company at 2.83%, and I believe a wiser play would be to wait for the growth to catch up with the valuation and see if the stock becomes available at a lower earnings multiple of under 20, and with a yield of over 3%.

Full Disclosure: As of this writing, I am long JNJ.
You can see my dividend portfolio here.

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Aflac: Still Undervalued, Still with Risk

-Revenue Growth Rate: 8.5% Dividend Stock Report
-EPS Growth Rate: 11.1%
-Book Value Growth Rate: 11.6%
-Dividend Growth Rate: 17.2%
-Current Dividend Yield: 2.23%
-Financial Strength: AA-, Aa3

Aflac’s core performance has been remarkable over the last decade, and they have improved their financial condition compared to last year. Concerns over a potential Japanese default are keeping the stock valuation low.


AFLAC Incorporated (NYSE: AFL) is a large international supplemental insurer. They provide cash that can cover several types of expenses to those receiving payouts due to illness or deaths. This is supplementary to primary medical insurance which helps cover medical expenses but leaves other expenses without a solution. This Fortune 500 company was founded in 1955, and has a large presence in Japan and the US. AFLAC stands for the American Family Life Assurance Company.

The company made a big move in Japan in the 1970s by selling insurance for cancers when people were becoming particularly mindful of cancer. Decades later, approximately three-quarters of Aflac’s diverse premiums now come from Japan.

Aflac primarily targets places of employment for its insurance products, rather than individuals outside of work. The company offers plans to employers that allow them to provide Aflac insurance as part of their benefits package to employees without paying any cost themselves.

The premise behind an insurance company is that they spread risk out over a wide number of people and businesses. They collect premiums (payments) from clients and in return those clients are covered in case of a serious loss. From an insurance business standpoint, it’s ideal to collect more in premiums than you pay out for losses. This is not the primary form of earnings, though. An insurance business, after collecting all of the premiums, holds a great deal of assets that, over time, are paid out for client losses. An insurance company constantly receives premiums and pays out for losses, so as long as they are prudent with their business, they get to constantly keep this large sum of stored-up assets. As any investor reading this knows, a great sum of money can be used to generate income from investments, and that’s how an insurance company really makes money. Aflac invests its stored up collection of assets primarily in fixed income securities to receive upwards of $3.4 billion in annual investment income.


Price to Earnings: 8.7
Price to Book: 2.1


Aflac Revenue
(Chart Source:

Aflac has had particularly strong core business performance over the last decade. Revenues from both premium income and investment income have increased every year for at least the last ten consecutive years, although this is so far not the case for the trailing twelve month period and it appears that the streak will be broken. The annualized revenue growth rate over the last seven years was 8.5%.

Earnings and Dividends

Aflac Dividends
(Chart Source:

Aflac has had somewhat erratic EPS numbers, but the average growth over this seven year period was 11.1% per year. EPS spiked to $7.20 over current the trailing twelve month period, which the chart doesn’t show. The company’s operating earnings per share, which excludes yen currency effects, impairments, and certain other items, has increased every year for over two consecutive decades.

As for the dividends, Aflac has increased the dividend for thirty consecutive years. The payout ratio is rather low, at under 20%. Despite the low payout ratio, the dividend yield at 2.23% is at least higher than the average S&P 500 yield, because the stock valuation is so low. The yield was closer to 3% last year before the stock price increased substantially. The payout ratio is actually lower than it was 5 years ago because earnings have strengthened recently and the dividend was only increased at a moderate rate, so I’d expect the dividend increases over the next few years to be rather generous.

Approximate Historical Dividend Yield at Beginning of Each Year:

Year Yield
Current 2.23%
2013 2.7%
2012 3.0%
2011 2.1%
2010 2.3%
2009 2.1%
2008 1.3%
2007 1.4%
2006 0.9%
2005 1.0%

As can be seen, the dividend increased quickly earlier in the decade but then began increasing more slowly during the worldwide financial crisis. This leaves extra room for dividend growth over the next few years, assuming their Japanese market remains reasonably strong.

Balance Sheet

The balance sheet dynamics have changed during the previous few years. The company’s large investment portfolio had significant exposure to some of the most financially troubled European countries, and this resulted in billion-dollar capital losses in the peak years of the problem. Aflac has managed that situation well, but now the issue that’s keeping the stock valuation low is their exposure to Japanese default risk.

Realized Investment Gains (Losses) By Year, in Millions:

Year Gain / (Loss)
Trailing 12 Months $471
2012 ($349)
2011 ($1,552)
2010 ($422)
2009 ($1,212)
2008 ($1,007)
2007 $28
2006 $79
2005 $262

Gains and Losses from the portfolio were a fairly minor portion of the business until 2008 when the financial crisis began showing itself. With over $1 billion in impairments in certain years, this kept the stock price and the stock valuation low.

Investment Thesis

Aflac has a notable business model. Rather than targeting individuals, Aflac insurance agents target businesses. Aflac works with employers to give employees the option to purchase Aflac Insurance via payroll deductions, similar to their other benefits. This “cluster-selling” technique keeps costs comparatively low, and gives the company a major competitive price advantage. It creates a win-win situation with employers it does business with.

In addition to having a solid distribution network for its insurance products, Aflac has a strong brand name that is well known in Japan and US, with the duck mascot. The brand is stronger than most other insurers, especially in Japan.

Plus, its insurance is rather resistant to health care reform or other insurance regulation (although not untouched). The company provides supplemental insurance; cash to people when they need it most.

The company has been recognized as one of the “World’s Most Ethical Companies” by Ethisphere Magazine, and also one of the best places to work. It has won similar awards from a variety of sources.

Aflac’s US exposure is significantly smaller than its Japanese exposure despite being a US-based company. Their customer retention rates are not as high in the US as they are in Japan, but the other side to this is that there is more growth and improvement opportunity.


Aflac, despite superior performance over the last decade, has faced some of the harshest macroeconomic problems there are. During the financial crisis, they had several billion dollars worth of exposure to bonds from the European countries that were being bailed out, which resulted in investment losses. Over the last year, this risk has shifted away from Europe and to Japan.

Japan is one of the world’s largest economies, and has the highest ratio of public debt to GDP out of any country in the world. The ratio is well over 200%, which is more than twice that of the United States. This has historically not been a problem for Japan for the last couple of decades because the strong economy kept interest rates low. As long as the interest rates were low, the debt was easy to maintain. (In comparison, those European countries with lower debt-to-GDP ratios began entering default during the financial crisis because investors lost confidence in the economies of those countries and interest rates spiked to unworkable levels.) The interest rates in Japan are still very low, so there’s still not a current issue. But, it has become increasingly clear to investors that Japan is heading to a problem. The debt is extremely high, and the economy is faltering from the declining and aging population. A declining population makes economic growth extremely difficult to obtain and can affect housing prices with extra supply (essentially the same problem as the United States faced but without the benefit of population growth which can eventually fix problems of over supply), while the aging population puts more stress on government programs and on younger taxpayers.

Aflac does most of its business in Japan and holds a considerable portion of its assets in Japanese debt. The extreme case of a Japanese default would be extremely damaging to Aflac. Quantitatively, about 40% of Aflac’s $100 billion+ investment portfolio is held in Japanese Government Bonds. That’s the portion that’s at risk if there were to ever be a government default, and additional risk would likely come from a reduction of premiums even in moderate scenarios without a default but with a debt/economic crisis.

Conclusion and Valuation

Wow, what a run. I published a report on Aflac 14 months ago suggesting that the price of under $46 at the time was appealing, even using an aggressive 12% discount rate, and the stock is now up to nearly $63. With dividends added, that’s a nearly 40% rate of return on paper in 14 months.

Dividend investors, however, are interested in long-term growth. The forward-looking question is whether the stock price remains attractively priced, or whether this run-up has taken the attractiveness out of the stock. To be sure, the current low P/E ratio of under 9 is very low, and lower than the historical average of the company. This makes their share buybacks particularly effective at boosting EPS. So, the share price increase has not been from an increase in valuation, but rather from an increase in reported earnings and a flat valuation on those increasing earnings, which translated into a substantially increased stock price.

To estimate Aflac’s fair value, we can do a two stage Dividend Discount Model. If the company grows EPS by an average of 9% going forward, which is below historical growth, then the dividend can increase at a rate of 12% per year over the next ten years to increase the payout ratio to only 30% at the tenth year. After that, the dividend could be assumed to grow at the same rate as EPS. Applying an aggressive 12% discount rate (the target rate of return), the calculated fair price is nearly $65/share, compared to the current actual price of under $63/share. In reality, EPS growth is not going to be smooth and it’s impossible to say what level management will want the payout ratio to be in ten years even assuming slowing of EPS growth. The point is, even assuming a slowing of growth, the company can be calculated to be at an attractive value for a 12% rate of return.

In a more conservative scenario, if the company grows the dividend by only 10% per year over the next 10 years followed by 7% thereafter, which is considerably below what has been typical for the company, and a less aggressive 10% discount rate (target rate of return) is used, then the calculated fair price is just under $64, which is comparable to the current price of about $63.

So, in a variety of scenarios, if Aflac continues operating normally, the stock is noticeably undervalued. The combination of dividend yield and dividend growth, with 30 years of consecutive annual dividend growth, is one of the better combinations you’ll find on the market.

Clearly, this undervalued status is due to very real concerns about the Japanese economy. If Japan has a default or otherwise has a severe economic contraction, all bets are off. EPS growth, and consequently dividend growth, will run into walls if Japan defaults or enters a more tangible economic crisis, and the portfolio value will be at risk. Aflac is considered a short opportunity for those that are bearish on the Japanese default risk, with some predictions of the stock price being cut in half over the next year.

For this reason, I continue to view Aflac as a dividend investment that has an above average risk profile and above average potential returns if those risks don’t unfold. Most investor portfolios do not have substantial direct exposure to Japan, so holding Aflac stock may be a way to diversify into a concerned region if you’re not as bearish on the economy of Japan as some are. Aflac at this time does not appear to be a good candidate for a core holding if you’re concerned about the Japanese economic risk, but should provide above average returns if the more bullish or optimistic views of Japan end up being correct.

Full Disclosure: As of this writing, I have no position in AFL.
You can see my stock portfolio here.

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